TRADING CASE RE2
Correlated payoffs and information revelation
LEARNING OBJECTIVE
Understand how prices reveal information when the payoffs of traded assets are correlated.
KEY CONCEPTS
Market efficiency | Rational expectations | Correlated payoffs | Price discovery
HOW THE CASE WORKS
Three stocks trade over two periods. Firm 1 competes in a separate market; Firms 2 and 3 compete for the same contract, so favorable news for one can be unfavorable for the other.
CASE DATA
| Event | Description | Firm 1 dividend | Firm 2 dividend | Firm 3 dividend |
|---|---|---|---|---|
| x | Wins no contracts | 0 | 0 | 30 |
| y | Wins some contracts | 12 | 15 | 15 |
| z | Wins all contracts | 24 | 30 | 0 |
MARKET SETTING
The interest rate is 0%. You may borrow and sell stocks short. Events determine Period 1 dividends and Period 2 liquidating values. Traders may receive truthful private information about events.
TRADING RULES
- Firm 3's event ordering is reversed: x is best and z is worst.
- Compare prices across Firms 2 and 3 because their contract outcomes are linked.
- Short positions must cover dividends and final values.
- After Period 2, all positions are converted to cash.
AFTER TRADING CLOSES
The realized event or economic path determines the security payoffs. Cash, long positions, and short positions are settled according to the case rules.
PERFORMANCE: Grade cash per trial = 0.0001 x closing market cash. Positive wealth adds grade cash; negative wealth subtracts it.